Tax Man Cometh Again: This Time for Executive Pensions

No more cream for fat cats if Congress gets its way. According to Financial Times journalists, Francesco Guerrera and Eoin Callan, the U.S. Senate votes this Tuesday to curb tax breaks tied to executive retirements. (See "Retirement tax will hit US executives - January 29, 2007). They write: "Under the new regime, executives would be allowed to defer up to $1m a year or the average of the previous five years’ taxable salary, whichever is lower. Any sum above that would incur taxes and a 20 per cent penalty."

I could not find any details posted yet to the U.S. Senate Finance Committee website but I'll scour C-SPAN tomorrow for the exciting showdown.

The real shame is that, once again, we have a "one size fits all solution" that does not differentiate between "excessive" compensation arrangements and what's required to attract and retain leadership talent. Ben & Jerry's earlier use of a salary cap made it difficult to lure a CEO to Vermont, despite the promise of an unlimited supply of Chunky Monkey and Cherry Garcia (the low-fat version being my personal favorite). Ditto for other companies that did not heed the supply-demand dynamics of a competitive marketplace. (Click here to read "Putting a Ceiling on Pay: No Whole Foods executive can earn cash pay of more than 14 times what its average worker makes. Will other companies follow?" by Andrew Blackman, Wall Street Journal - April 12, 2004).

By extension, if deferred compensation at a certain level facilitates the hiring of a skilled CEO, why should it be discouraged? Shareholders may save money in the short-run but lose in the long-run. This could include 401(k) and defined benefit plan participants whose fortunes rise or fall with the price of company stock.

This story has legs, especially now that many experts predict a return to populism and a move against "mean, greedy executives."

Editor's Notes:

1. The topic of optimal executive compensation is broad and complex. However, there is real merit in letting companies self-police AS LONG AS shareholder stewards do what they are supposed to do. Be vigilant. Ask questions. Exercise proper fiduciary oversight.

2. Click here if you want to read last week's blog post about the proposed taxation of health care benefits. posted by Susan Mangiero at 1/29/2007 04:44:00 AM | 0 comments | links to this post   

Union Pension Power

In response to a request from the United Brotherhood of Carpenters and Joiners of America, American Express Co. is slicing retirement benefits for top executives by more than ten percent. According to Wall Street Journal reporter Robin Sidel, the changes "come amid shareholder criticism over supplemental executive retirement plans, or SERPS, that award big pay packages to departing executives." (See "Top Executives at American Express Will See Retirement Benefits Shrink" - January 27-28, 2007).

This is not the first time that unions have taken an activist stance nor will it likely be the last. Check out the long list of Annual Group Meeting (AGM) resolutions brought by union pension plans, courtesy of Ms. Jackie Cook, a researcher on director interlocks and corporate social responsibility. Click here to access the list.

Now that new, and arguably more rigorous, SEC executive compensation disclosure rules are in effect, it will be interesting to observe union response. Will juicy corporate pay packages encourage even more attempts at reform? Will rank-and-file workers find it difficult to lobby for cuts in executive perks while asking for personal hikes? How will the dual role of employee and shareholder affect union clout?

"Workers unite" could start to take on an altogether different meaning.

Labels: Unions

posted by Susan Mangiero at 1/28/2007 08:00:00 AM | 0 comments | links to this post   

New Rules for Soft Dollars - Pension Buyers Beware

In his July 12, 2006 speech, SEC Chairman Christopher Cox describes soft dollars as "inflated brokerage commissions" and urges reform to ensure their use for research only. "Commission Guidance Regarding Client Commission Practices Under Section 28(e) of the Securities Exchange Act of 1934," issued a week later, sought to clarify the extent to which money managers could properly purchase research without breaching their fiduciary duties to "seek the best execution for client trades, and limit money managers from using client assets for their own benefit." (Click here to access the 63-page file.)

Attempting to promote better transparency in trading costs, the SEC emphasizes "the statutory requirement that money managers must make a good faith determination that commissions paid are reasonable in relation to the value of the products and services provided by broker-dealers in connection with the managers’ responsibilities to the advisory accounts for which the managers exercise investment discretion." Another stated goal is to help money managers with pension fund clients avoid ERISA non-compliance as relates to soft dollars.

At a time when Congress is joining the fray about pension fees, little has been said about the SEC's dictate that "Market participants may continue to rely on the Commission’s prior interpretations for six months following the publication of this Release in the Federal Register, that is, until January 24, 2007."

January 24, 2007 has come and gone. Where's the fanfare? A topic as important as this merits discussion.

Labels: Fees, Investing, Soft Dollars

posted by Susan Mangiero at 1/26/2007 12:06:00 AM | 0 comments | links to this post   

Et Tu New York? What Deregulation Means to Pension Funds

According to Financial Times reporter David Wighton ("Regulation a threat to New York, report says", January 22, 2007), New York City stands to lose nearly 60,000 jobs over the next five years in the absence of significant regulatory reform. A McKinsey & Company report, commissioned by Mayor Michael Bloomberg and Senator Chuck Schumer, extols the virtues of London and other venues that are considered more user-friendly for derivatives trading and other financial service activities.

Mr. Kevin LaCroix, creator of the informative blog, The D&O Diary, provides a link to the report and some interesting comparisons with the Paulson report that likewise pleads for liberalization of U.S. capital markets.

While free marketeers applaud initiatives that permit capitalism to do its magic of bringing together diverse buyers and sellers, consider some recent statistics from the Conference Board.

1. In 2005, U.S. institutions such as pension funds, insurance companies, banks and foundations controlled $24.1 trillion in assets.

2. In 2005, these institutional giants owned 67.9% of the equity of the largest 1000 corporations versus 61.4% in 2000.

3. In 2005, four companies revealed institutional investor ownership in excess of 70%. In 2004, the number was two and one or none before then.

4. Public pension plans continue to prevail in important corporate matters. Co-author of the 2007 Institutional Investment Report (Report #1400, The Conference Board), Dr. Carolyn Kay Brancato, Senior Fellow and Director Emeritus of The Conference Board Governance Center describes their critical role. "Ten years ago, these funds weren't likely to join in lawsuits or exert pressure in out of court settlements, but now, having been severely burned by the Enron and WorldCom situations, these funds are asserting themselves as never before. In addition, as the election of directors becomes more heated, and as many companies adopt bylaws saying their directors will resign if they don't get a majority of shareholder votes, the voting clout of these activist investors becomes more meaningful."

What does this mean?

As stewards of trillions of dollars of retirement monies, pension fiduciaries must serve as the first line of defense with respect to sniffing out corporate misdeeds or identifying boards that are "oversight challenged." Already tasked with a daunting job, deregulation compels these watchdogs to do an even more rigorous search for red flag issues BEFORE they turn into financial calamities.

This goes back to a recurring theme of this pension blog. Do pension fiduciaries have what it takes? On what basis are they selected? How are they trained? Is there a pension fiduciary who can serve as a Sarbanes-Oxley type "financial expert," someone who understands how to go beyond financial statements to detect possible trouble? Are the right mechanisms in place for pension fiduciaries to gather adequate information about corporate policies, procedures and internal controls AND then evaluate the data in a meaningful way? Are fiduciaries compensated in such a way that encourages their active participation, before the fact? How has the role of lead plaintiff changed in the aftermath of the Private Securities Litigation Reform Act of 1995 and can litigation replace regulation?

I'm not saying that statutory regulation is a panacea. In fact, there is great comfort in being part of a system that permits a vigorous debate about the numerous merits of industry self-review.

As patriot Thomas Paine declared: "Those who expect to reap the blessings of freedom, must, like men, undergo the fatigue of supporting it."

Labels: Governance, Regulation

posted by Susan Mangiero at 1/24/2007 06:00:00 AM | 0 comments | links to this post   

The Tax Man Cometh to Health Care

According to "Bush Bids to Increase Focus on Health Care with Plan on Tax-Based Aid for Consumers" (Wall Street Journal, January 22, 2007), the White House intends to curb skyrocketing health care costs by seeking tax relief for some. Journalists John D. McKinnon and John Harwood write that independent buyers of health insurance would get a tax deduction, arguably a boon for the millions of persons who are self-employed or work for companies that do not provide insurance. In contrast, employer-provided health insurance benefits would constitute taxable income. Likely winners include an estimated 80% of employees for whom the average premium (for a family policy) is a reported $11,500. Executives, professionals and some "rank-and-file" union workers may not be so lucky.

In a related article, "UAW May Run Some Retiree Benefits" (Wall Street Journal, January 23, 2007), reporter Jeffrey McCracken describes a "potentially revolutionary plan" whereby the United Auto Workers could assume responsibility for a ten billion dollar plus liability. A critical question is whether big U.S. auto manufacturers can find the money to finance "a handover of future retiree health-care obligations to a union-managed fund." Beyond costs, McCracken posits that union leaders face a real dilemma. Accustomed to negotiating hard on behalf of their members, can or will they want to police members' health care activity as a way to control costs?

As stated here and elsewhere, health care has the potential to dwarf the pension issue in a serious way. (Click here to read our most recent post about health care economics.)

If employers decide they can't afford to offer insurance coverage in its current form, pensions may be curtailed even further as part of a serious look at employee benefits overall. This is not necessarily a good thing if companies and municipalities then find it difficult to attract and retain productive workers.

Add the questionable state of Medicare to the mix and the current situation looks bad. With the 2008 election frenzy already underway, we're sure to hear more about health care solutions. Generating a meaningful dialogue (no sound bites please) is good. Without radical surgery soon, we're in for a long recovery.

Labels: Health Care

posted by Susan Mangiero at 1/23/2007 05:30:00 PM | 0 comments | links to this post   

Get Your Hands Off My Retirement Piggybank

Some things never change. On November 27, 1994, I wrote an op-ed piece for a local newspaper entitled "A prescription for Social Security" in which I warned of the entitlement mentality and the crushing debt load soon to be foisted upon young people everywhere. According to the editor, my suggestions for funding reform were not well-received, as evidenced by a flood of letters with the same message. "Keep your hands off my federal piggybank" and let someone else pay the price. (Like many others, I am an advocate of phased-in privatization for those who prefer to save on their own.)

Recognition of big problems ahead is certainly not unique to me. In his 1993 book, Generational Accounting: Knowing Who Pays, and When, for What We Spend, Dr. Laurence J. Kotlikoff warns of the great divide between the young and old. In their 2005 book, The Coming Generational Storm: What You Need to Know about America's Economic Future, Kotlikoff and co-author Scott Burns tell a grim tale of what has been chronicled many times before. A disproportionate number of persons are retiring from the work force, leaving those who remain to bear the staggering burden of a "pay as you go" system in the form of Social Security and Medicare.

Published last May, the 2006 Social Security Trustees Report states: "Over the 75-year period, the Trust Funds require additional revenue equivalent to $4.6 trillion in today’s dollars to pay all scheduled benefits. This unfunded obligation is $600 billion higher than the amount estimated last year."

New York Times reporter Steven R. Weisman writes that Federal Reserve chairman Ben S. Bernanke is worried too, asserting that "Recent positive trends on the budget were a 'calm before the storm,' to be undone by huge deficits in federal entitlement programs. In "Fed Chief Warns That Entitlement Growth Could Harm Economy" (January 19, 2007), Weisman describes Senate testimony that sounds downright gloomy. "The longer we wait, the more severe, the more draconian, the more difficult the adjustment is going to be."

Unfortunately, as we know too well, attempts at entitlement reform are political folly and so the problem festers with little hope of short-term remedy

There are plausible solutions (hard ones but they do exist) IF only people would give up the ghost of an actual retirement piggybank in Washington, emblazoned with their names. In this case, Virginia - there is no Santa Claus.

Sorry kiddo!

Labels: Entitlements, Medicare, Social Security

posted by Susan Mangiero at 1/19/2007 12:52:00 AM | 0 comments | links to this post   

Gray Power - Economic Implications

Credit illustrator Mike Dowdall for this delightful figurine. Now Art Director for Westland Giftware, after stints with Dakin, Portal, Hallmark and Bradford Exchange, Dowdall has created an entire line around the idea that "old is happening." (Click here to see more of his work.) Seeing a selection of this new product line in a local gift shop, I enjoyed a few chuckles but that's not all. It's yet another indicator that we are in for a radical change with respect to all things demographic. After all, no company is willing to commit funds unless they anticipate commercial success with lots of "geezers who get it."

Consider the following facts reported in "The Profile of Older Americans - 2005," published by the U.S. federal government. (Click here for a copy of the report.)

<< The older population (65+) numbered 36.3 million in 2004, an increase of 3.1 million or 9.3% since 1994. The number of Americans aged 45-64 – who will reach 65 over the next two decades – increased by 39% during this decade. About one in every eight, or 12.4 percent, of the population is an older American. Persons reaching age 65 have an average life expectancy of an additional 18.5 years (19.8 years for females and 16.8 years for males). Older women outnumber older men at 21.1 million. >>

This seismic shift in population make-up has the potential to impact every aspect of the U.S. labor landscape, not to mention the economic well-being of Corporate America. New York Times reporter Elizabeth Olson discusses the increased number of gray-friendly job boards. In "Some Web Job Sites Put Out 'Gray Hair Welcome' Signs," she writes: "Of the estimated 76 million baby boomers reaching retirement in coming years, some will start businesses. But the majority who continue to work will seek the familiarity and security of a regular paycheck."

At roughly twenty-five percent of total U.S. population, workers over 55 years could exert some serious bargaining power. Companies in desperate need of skilled workers will likely rethink their HR policies, including benefits that appeal to the "seasoned" set. That's on top of the oft-discussed cost of funding benefits for individuals whose lifespans are outpacing that of the trademarked Energizer Bunny.

Parenthetically, this pattern is not unique to the U.S. and arguaby more pronounced in countries such as Italy and Japan. Former U.S. Census Bureau Director Martha Farnsworth Riche describes "expensive housing, inflexible work practices, and persistence of traditional gender roles" as reasons for a reduction in new births, making seniors a large cohort in both an absolute and relative sense. (See "Population Aging: National Differences Make a Difference" - January 2004.)

Email us if you'd like some help in quantifying the relationship between demographics and your company's bottom line.

Labels: Demographics

posted by Susan Mangiero at 1/14/2007 02:29:00 PM | 0 comments | links to this post   

Pension Solutions

With all the talk about problems (and there are plenty of them), I think it's important to focus on solutions (and there are plenty of them too).

What pension problem would you most like to solve? Click here to email us with your input. Please let us know if we have permission to post your response and, if so, whether you want us to include your name. (We will post comments anonymously unless you tell us expressly we can use your name.)

Labels: Solutions

posted by Susan Mangiero at 1/11/2007 12:20:00 AM | 0 comments | links to this post   

Pension Regulation - Driving Under the Influence of a Muffin

I live in a lovely town of about 18,000 people. Thankfully, there is little crime other than an occasional act of mailbox vandalism or the theft of holiday inflatables. Credit good-hearted people and a vigilant police force, especially it seems, when it comes to driving. I know this firsthand because I was pulled over the other day for DUIM (driving under the influence of a muffin, blueberry in this case). Apparently, I was swerving slightly to the right even as I drove a cautious twenty-five miles per hour. When I rolled down my window to say hello, the police officer saw the muffin, gave me a warning not to eat while driving and said he was on the lookout for DUI's (driving under the influence). After I thanked him, a bit shaken for the experience, I got to thinking.

Can rules be too rigid and what happens when you cross the line ever so slightly?

These thoughts are not unique to me. The topic du jour in financial policy circles is whether regulation is too heavy-handed and thereby impedes capital market innovation. Just last week, wonk wizard and New York Times columnist Ben Stein queried the wisdom of the so-called Paulson Committee in seeking to redress the "onerous" audit standards attached to Sarbanes-Oxley. (See "So Many Millions, So Little Body Armor", January 7, 2007)

Citing a plethora of option problems on Corporate Boulevard, he asks: "Isn't backdating precisely an example of a failure of internal controls? Haven't we just found out that internal controls are far too lax, not too strict?"

The same question, applied to benefit plan governance, is apt. At a whopping 908 pages, the Pension Protection Act of 2006 has spawned a new industry to decipher the nooks and crannies of this far from simple regulation. Too soon to assess the fallout, one ponders. Could it be too much? If so, what can take its place?

I'm a big believer in industry self-regulation but that begs yet another question. Who represents the "pension industry" and do the players speak with one voice? Arguably, HR has a different perspective than Audit or Treasury. Without a unified world view about what pension governance means, it's hard to imagine a system without mandatory regulation.

Free marketeers will say this is troublesome. The regulatory burden is far from trivial. Real dollars are redirected to activities that may not reap rewards. Perverse incentives arise and the law of unintended consequences results. Look what happened in the UK. In the aftermath of FRS 17, a large number of companies terminated defined benefit plans as quickly as possible.

Then there is the issue of compliance. Many suggest that pension regulatory changes are outpacing the industry's ability to keep up. Does this put a fiduciary in harm's way (the equivalent of swerving slightly while eating a muffin)? You think you're doing the right thing but get "pulled over" nonetheless. How can a decision-maker protect herself (himself) from mounting personal and professional liability?

Here's to pension governance solutions - the sooner the better!

Labels: Regulation, Solutions

posted by Susan Mangiero at 1/11/2007 12:02:00 AM | 0 comments | links to this post   

Pension Accountants - Where Are You?

A crisis is upon us. According to Wall Street Journal reporter Ronald Alsop, U.S. business schools are scrambling to find qualified professors in accounting, finance and management, respectively. (See "Ph.D. Shortage: Business Schools Seek Professors, January 9, 2007) Alsop offers sobering statistics, courtesy of the Association to Advance Collegiate Schools of Business (AACSB International). A current estimated shortage of 1,000 Ph.D.s is expected to grow to 2,400 by 2012. Supply and demand dynamics are in full force with B-school salaries on the rise. Unfortunately, money alone will not help. Someone starting doctoral studies today will be lucky to finish by 2011 and that's if they attend on a full-time basis, ignoring the lure of Wall Street.

While one can reasonably dispute the merits of putting Ph.D.s in the classroom (versus industry practitioners), the reality is that business school accreditation mandates certain coverage ratios. When too few academically qualified professors are available to teach, courses are cut, class size is reduced and/or admissions are scaled back.

Under any of these scenarios, fewer students become business school graduates. The resulting dearth of trained technicians is problematic. At a time when new pension accounting rules are upon us, investing is global and financial engineering requires more than a passing knowledge of basic concepts, where will much-needed expertise come from?

Labels: Challenges, Investing, Training

posted by Susan Mangiero at 1/10/2007 12:08:00 AM | 0 comments | links to this post   

Paper Clip Theory of Pension Governance

In speaking to a colleague about managerial excesses the other day, I relayed the story of something that took place years ago. I was in college and worked as a bank teller in the afternoons and opened new accounts on Saturdays. The woman assigned to provide on-the-job training (long retired I'm sure) chided me for tossing a paperclip. "I'm a shareholder of this bank and every penny counts. We just don't throw away paperclips."

At the time, she struck me as old-fashioned and picky. Of course, when you're twenty, I suppose everyone seems un-cool.

What continues to amaze me is that I recall that event as clearly as if it had just happened. Her comment was an epiphany of sorts. This woman was not an executive. She wasn't even a bank officer. She was a secretary (administrative assistant in today's parlance). She wasn't responsible for the budget. No one counted supplies. Certainly one abandoned clip couldn't mean much. Yet her words resonate still. With skin in the game, she had a compelling motivation to be thrifty and encourage others to follow suit.

The relevance to pension governance is striking. When fiduciaries do not have a vested interest in adhering to best practices, will they be tempted instead to follow the path of least resistance? What motivates an individual to be a good steward of other people's money? Is it an increasing awareness of personal and professional liability that moves people to act or a concern that doing the right thing counts most?

A few days ago, I asked several financial advisors why they thought so many lawsuits focus on 401(k) fees rather than defined benefit plan fees. One response speaks volumes. "It's the company's money with DB plans but when employees pay, there is less managerial concern." Cynical or a reflection of the existing risk-reward system? Fiduciary responsibilities apply to both DB and DC plans. Yet decision-makers tend to feel pain faster and more fully when DB plan assets underperform and their compensation is tied to share price, cash flow or budget variance.

Experts agree that pension governance is AWOL at more than a few companies and statehouses. Why is that? As I wrote in Executive Decision last year, incentives are everything. Reward people for good behavior and you get what you pay for. The converse is true as well.

For those already in the vanguard with respect to effective investment fiduciary practices, kudos and keep up the great work. For those doing the equivalent of the pension paperclip toss, a good New Year's resolution is to stop.

P.S. Click here if you'd like to read "Do Fiduciaries Need Better Incentives to Make the Retirement System Work?"

Labels: Executive Compensation, Fiduciary Responsibility, Governance, Stewardship

posted by Susan Mangiero at 1/05/2007 06:02:00 AM | 0 comments | links to this post   

Pension Contagion - Should We Worry?

Similar to many of my peers, I spent the last few days in the same shape as this fella. Anxious now to avoid suspicious coughs or sneezes, I've been pondering what contagion might look like in the pension world. The upshot? Not a pretty picture.

Broadly defined, the spread of bad financial news, like a transmitted disease, moves quickly, has the potential to wreak havoc and is hard to contain once unleashed. This is why policy-makers worry about anything that can accelerate diminished investor confidence and panic market participants into selling off positions they would otherwise choose to hold.

Contagion itself is dangerous but when you consider what some describe as an inevitable convergence towards one global market, with trading that occurs 24/7, the potential for serious harm is real. Continued technological advances, international deregulation and investors' willingness to go offshore promote lightening speed information flow. When bad news hits, it's the shot heard 'round the world. Having worked on three trading desks during volatile times, I know firsthand how quickly things can change.

Taking a page from science, the "butterfly effect" describes how tiny changes can lead to large-scale disturbances. Click here to read about meteorologist Edward Lorenz and his seminal work in chaos theory. Does his notion that the flap of a butterfly's wings in Brazil can set off a Tornado in Texas apply to pensions?

Let's consider some facts.

1. The graying of the global population is real.

2. Life expectancies are climbing in the U.S. and in most developed countries.

3. Countless U.S. and non U.S. government plans are hamstrung by reluctant taxpayers, binding labor contracts and defined benefit plans with fixed terms.

4. Regulatory reform here and abroad has accelerated the need for liquidity.

5. Companies around the world rely on higher return (read higher risk) investments to close the pension gap.

6. Shareholders in U.S. companies are preparing for the worst with the first batch of annual reports that reflect FAS 158 compliance, similar to the FRS 17 effect in the UK. GASB 45 is keeping public plan leaders up at night.

7. Many companies outsource or have global staffs with benefits offered to all.

8. Different country governments and multinational companies alike invest in each other's securities.

Market returns are correlated. Labor mobility exists. Companies buy and sell around the world. News travels fast.

What does that infer? Pension contagion is a real possibility.

Editor's Note:

The World Bank website links to some research papers about financial contagion that may be of interest.

Labels: Economic Conditions, Policy

posted by Susan Mangiero at 1/04/2007 12:04:00 AM | 0 comments | links to this post